For Microsoft, Skype Opens Vast New Market in Telecom

In agreeing Tuesday to pay $8.5 billion to buy Skype, the pioneer in Internet phone calls, Microsoft is embracing a technology that is transforming the way people communicate at home and at work. And by stitching Skype technology into Microsoft products, used by hundreds of millions of people, the software giant could hasten the mainstream adoption of video communications, especially in businesses.

Microsoft, although rich and powerful, lags in new fields like smartphone software. Skype could help it better compete with the new giants of technology, like Google and Apple.

“Skype has been a forerunner, and this deal is Microsoft trying to become relevant in this new age of Internet communications,” said Berge Ayvazian, a telecommunications consultant. “It could really change things for Microsoft and accelerate the spread of this new technology.”

The future of communications, industry analysts and executives say, will be animated by Internet technology and rests increasingly on video calls, as well as voice and text messages. Skype started on personal computers less than a decade ago, but is now beginning to make its way onto smartphones. As it heads for living rooms with applications like at-home videoconferencing on digital televisions, it could change the way people make even the most routine calls.

This next generation of communications is both a threat and an opportunity to telecommunications and technology companies — a focus of energy, investment and anxiety for corporations including AT&T, Verizon, Apple, Google and Facebook.

Microsoft is betting that Skype can help change its fortunes. Skype is a leader in Internet voice and video communications, with 170 million users each month connected for more than 100 minutes on average. In the last year or two, video use has surged, now accounting for 40 percent of Skype’s traffic.

That large and active community of users represents a major asset, said Steven A. Ballmer, Microsoft’s chief executive. “It’s an amazing customer footprint,” Mr. Ballmer said in an interview. “And Skype is a verb, as they say.”

Mr. Ballmer never mentioned Google, Microsoft’s archrival whose name is used as a verb for Internet search. In that market, Microsoft is spending heavily to try to catch Google, and making some progress with its Bing engine, but at great financial cost.

Google, like Skype, has a free Internet phone call and video messaging service. So Microsoft, analysts say, is taking a bold step to grab a leadership position instead of risking falling behind Google in a crucial market and then facing the difficult task of trying to catch up.

“Skype gives Microsoft instant size and scale in this emerging market,” said Howard Anderson, a senior lecturer at the Sloan School of Management at the Massachusetts Institute of Technology. The merger with Skype, if successful, could give Microsoft a leading consumer Internet service — something it has lacked — and help lift its other businesses, like smartphone software, Office productivity programs and Xbox video game consoles, analysts say.

In doing so, Microsoft aims to keep people seamlessly connected at work or at home. “We want to enable communications across people’s lives,” Mr. Ballmer said in a press conference in San Francisco.

Skype, founded in 2003, is a creation of the new technology that is transforming telecommunications. “For some time, it has been clear that telecommunications is going to move to all-digital Internet technology,” said Kevin Werbach, an associate professor at the Wharton School of the University of Pennsylvania and a former official at the Federal Communications Commission. “Skype shows what can be done.”

Skype was founded by two entrepreneurs, one Swedish and one Danish, with software developed by a small team of programmers in Estonia. They deployed a version of peer-to-peer software, initially associated with illegal file-sharing of pirated music and movies. The voice and video travel over the Internet rather than dedicated phone landlines or cell tower networks.

Skype has had a bumpy ride as a business. EBay bought it for $2.6 billion in 2005, and then sold most of it to a private investors’ group in 2009, after eBay could not figure out how to make money on Skype.

 

DealBook: Microsoft in Talks to Acquire Skype for $8.5 Billion

12:20 a.m. | Updated

Microsoft is in advanced talks to acquire Skype, which revolutionized telephone calls over the Internet, for $8.5 billion, including the assumption of debt, according to people involved in the negotiations.

A deal is expected to be announced Tuesday morning, these people said, although they cautioned that the talks could still fall apart. A spokesman for Skype declined to comment, and calls to Microsoft were not returned.

The acquisition would be Microsoft’s largest ever and it is the software giant’s effort to gain a foothold in the world of voice and video communications. Microsoft would be able leverage Skype’s more than 600 million registered users into using its other products. For example, it could be connected to Microsoft’s Xbox 360 and Kinect systems, ?and integrated into the company’s flagship product, Office, as a way for business users to better collaborate.

It could also help Bing, its search engine, which competes with Google. It may also help bolster Microsoft’s fledging mobile telephone offering, which lags far behind Apple’s iOS and Google’s Android operating systems. The deal would end months of speculation in Silicon Valley about Skype’s future. The company had been planning an initial public offering but delayed those plans last year, leading to persistent rumors that it would be sold to another technology giant like Facebook, Google or Cisco Systems.

News of the deal and Microsoft’s interest in Skype was first reported by The Wall Street Journal online and the technology site GigaOM.

Skype has some 663 million registered users, the company said in a recent filing. Although most of its services are free, Skype makes the bulk of its profits from a small fraction of its users who pay for long distance calls to telephone numbers. Despite its popularity, the service has struggled to maintain profitability; in 2010, Skype made $859.8 million in revenue but recorded a net loss of $7 million, according to its filing.

Skype burst onto the scene in 2003 and has long been seen as a challenger to the telephone companies because it can route phone calls — and video calls — over the Internet free or for a nominal fee. Most telephone carriers have come to accept Skype, but still see it as a potential threat. It is unclear how the wireless carriers that support handsets with Microsoft’s operating system would view the deal and how tightly Microsoft would seek to integrate Skype into mobile.

Microsoft, analysts say, is making a move to block Google from gaining greater ground in Internet communications.

“This is part of the strategic fight between Microsoft and Google,” said Rob Enderle, an independent technology analyst.

Facebook, Mr. Enderle said, has a large market value, but not the cash to do deals as Microsoft does. “Microsoft is backing Facebook’s play, and to some degree entering this fight on Facebook’s side of this strategic confrontation with Google,” he said.

Microsoft, analysts say, has often been an astute acquirer of start-ups and smaller companies, picking off technical teams that are then folded into products likes Windows, Office and Internet Explorer. But during Steve Ballmer’s tenure as chief executive, beginning in 2000, the company has also made far larger, riskier bids, mostly unsuccessful.

In 2004, Microsoft entered into talks to buy the big business software company SAP, for about $50 billion, according to testimony that came out in a court case.

In 2007, Microsoft acquired aQuantive, an online advertising company, for roughly $6 billion, a sizable premium, and some suggested it overpaid.

Nearly three years ago, the company made a surprise $48 billion offer for Yahoo. Talks then broke off, and Microsoft withdrew its bid, but later reached a partnership to take over Yahoo’s search business.

If a deal for Skype is reached, it would be the second time a technology giant has acquired the company. EBay bought Skype in 2005 for $2.6 billion with hopes of tightly integrating the service as a sales tool.

But the deal never lived up to its promise and eBay took a $1.4 billion write-down on its investment. Skype was sold in 2007 to a consortium of investors led by Silver Lake Partners, Index Ventures, Andreessen Horowitz and the Canada Pension Plan Investment Board. Marc Andreessen of Andreessen Horowitz, who co-founded Netscape Communications, was seen as a pivotal matchmaker for Skype, at one point trying to put it together with Facebook, another company for which he is on the board, according to people involved in the discussions.

JPMorgan Chase and Goldman Sachs are advising Skype.

Evelyn M. Rusli and Verne Kopytoff contributed reporting.